Time For VCs To Start Pitching Startups?

from the shoe-on-the-other-foot dept

Back during the boom years, newly minted MBAs seemed to believe that the only way to start a company was to take their cocktail napkin scribble to a VC and get startup cash. The VCs didn't mind getting in early. They claimed their connections and know-how were necessary, but a bit of ancedotal evidence and some research suggests entrepreneurs are realizing that's not the way it needs to be done. In all honesty, it's always been the case that most startups are not right for venture capital -- but even those who will need it eventually can do quite well for themselves by bootstrapping. The recent sales of Topix and Bloglines are two cases in Silicon Valley where seasoned founders (who know both the upsides and downsides to VC funding) bootstrapped companies, passed on the VC money and sold their companies instead. The deals appear to give the start-ups access to capital to grow their businesses, some upfront payout for their hard work and continued control over the business. Going the acquisition route as opposed to taking funding and shooting for an IPO may have limited the upside of the founders, but the entrepreneurs are still making out well. VCs may discover that they need to rethink the "value proposition" they offer to a new generation of hot startups that seem more skeptical of the typical VC route.

Bootstrapping

The odds of a founder walking away with money after accepting VC money are tiny. Bootstrapping allows the Founders to change the odds of starting a company. Remeber Founders are all in, like in Texas Hold'em. VC have diversified their risk across multiple investments. VC money should only be used if you plan on getting access to Wall Street money.

VC and Money

The relationship with VCs can depend on what you want to create. If you're interested in developing a capital intensive product (e.g. phone switch, nifty vaccine), then you need a lot of capital to get your vision off the ground. If you can develop a growing, self sustaining, "somewhat viral" business, you should definitely fund it yourself and pass on the VCs. I'd suggest that even in the capital intensive startups, you seed the business yourself and convert your investment into the same preferred stock the VCs are funding you with. I got two things from the VCs: money and advice on how not to make stupid mistakes.

Done it both ways

I've founded three bootstraps and two VC-funded businesses (and in addition been on the boards of both kinds). Which works best depends on a lot of factors. If you can manage without any outside investors than almost unquestionably you should.

There are great investors who really do bring all three of money, connections and helpful advice. Unfortunately they are few, so most people by definition won't be able to meet or work with them.

But on the other hand, though I have heard all the "horror stories" of investors sucker-punching founders etc, when I drill on the story it usually turns out not really to be true. I have directly seen two companies destroyed by idiots on the board, but then again I've seen many more destroyed by stupid founders (one of which was one of my own, sigh).

Luckily for most readers of this blog, software companies usually have quite minimal capital requirements, so bootstrapping is easier for most of them.

Bootstrapping

Great finds and blurbs, Mike. Let us now forget the value of bootstapping.

Here is a site I like w/ equity tables on bootstrapping vs. raising venture capital. Also, a lot of good content on bootstrapping by a chap that has done it. I would encourage Techdirt fans to read it:

Re: Bootstrapping

Bootstrapping has obvious merits, and is the model I've been following so far in my venture, but now I find myself at a stage where we have an opportunity for growth and expansion, but can't keep bootstrapping it...so, should we do the VC dance (and jump through all the usual hoops), or focus on the angel route which is easier (imho) but carries its own risks.

In my own experience, I have encountered both angels and VCs (pre dot com crash) that were too control oriented and the effective intangible "cost" of their investment was heavy maintenance by the executive staff...it might have been a lot easier for us if we were more aggressive and choosy about which investors we accepted and which we should have passed on.

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Respobse

Grier on Techdirt comments that some founders who opt not to take on VC financing can do quite well by bootstrapping. Indeed he is right. VC financing is expensive (liquidation preferences, etc) and takes a sizeable % ownership (not to mention strain to grow company faster than normal) chunk out of one's business. It certainly is not for everyone.

That said, it is important to note that many of the more capital intensive startups - the ones that command higher acquisition values - do require VC financing. There is a correlation between risk return to the amount raised and the dollar out. Of these capital intensive investements, VCs are hoping to hit a home run. And, 2, 3 home run investments can return all the committed capital (and more) in a VC fund. See Google.

An example of this is Cisco's acquisition of Airespace for over $450M. Founder Hae Nahm and Storm Ventures, collectively, will pocket over $100M in a matter of 3 years. What an amazing IRR. Compare this home run to the "triple" that Topix and Bloglines founders hit. Though the Topix and Bloglines founders made out, they certainly did not hit a home run.

Another example is Liquidnet, where the founders - Seth Merrin and team - grossed over $200M, at least, in a sale to the later stage private equity companies. Liquidnet previously raised VC money from TH Lee and others.